Netflix: How a DVD Rental Service Replaced Its Own Business

Why Netflix is instructive for small businesses

Every service has a lifespan. The heating system that sells well today will hardly be installed in twenty years. The advice in demand today will be handled by software tomorrow. Owners know this. Still, it is hard to replace your own, still profitable business with something new while it is running. Usually a competitor ends up doing it.

Netflix is one of the rare documented cases in which a company deliberately replaced its own core business. The guiding question of this case study is: how did a DVD rental service manage to replace its own business with a new one, and what can small businesses take from it? To answer it, we first compile the facts, then explain the mental model of self-cannibalization, look at the mistake of 2011, and weigh two readings.

If you do not replace your best business yourself, you leave that job to someone else.

The documented facts: from the red envelope to streaming

Netflix was founded in California in 1997 by Reed Hastings and Marc Randolph. The business model was initially renting DVDs by mail: customers chose films online, received them in an envelope, and sent them back. With this, Netflix took on video rental stores, above all the Blockbuster chain.

An often-told episode dates from 2000. According to Marc Randolph, the founders offered Netflix to Blockbuster for 50 million dollars at the time and were turned down. Blockbuster's side disputes that serious negotiations took place. What is certain is what followed: Blockbuster filed for bankruptcy in 2010, and Netflix kept growing.

The time span is notable. Sixteen years passed between the launch of streaming and the end of DVD rental. So Netflix did not switch off the old business but let it run down while the new one grew. Shortly before the 2011 spin-off attempt, the DVD service still had more than 16 million subscribers. Since 2025, Netflix no longer publishes quarterly membership numbers and only reports when certain milestones are reached.

The mental model: the willingness to cannibalize

In marketing, cannibalization means that a new offer takes customers and revenue away from your own existing offer. Most companies try to avoid it. Rajesh Chandy and Gerard Tellis (1998), by contrast, studied why some companies are more successful than others at producing fundamentally new things. Their thesis: the difference lies less in size than in the willingness to cannibalize, meaning how far a company is prepared to reduce the actual or potential value of its own investments.

According to Chandy and Tellis, this willingness is an attitude of decision makers rooted in the company's culture. Market leaders hesitate because they have invested heavily in the existing business. Three forces can overcome this hesitation: internal markets in which units compete with each other for resources, influential product champions, and a focus on future rather than current markets. In a survey across three high-tech industries, the willingness to cannibalize explained radical innovation better than company size.

Govindarajan, Kopalle, and Danneels (2011) found a related result in data from 128 business units of large US corporations: the willingness to cannibalize was associated with innovations that open up new customer groups, but not with technically radical innovations for existing customers. This fits the Netflix case well. Streaming was not technically superior at first; the selection was far smaller than the DVD catalog. But it appealed to customers for whom convenience mattered more than choice.

The mistake of 2011: how not to explain a transition

The transformation did not go smoothly. In 2011, Netflix separated its plans for DVD and streaming in the US. According to press reports, anyone who wanted both paid around 16 instead of 9.99 dollars a month, roughly 60 percent more. Shortly afterward, the company announced it would spin off DVD rental under its own name, Qwikster, with its own website. After fierce criticism, it withdrew this announcement within a few weeks.

In the third quarter of 2011, according to press reports, Netflix lost around 800,000 US subscribers, and the number fell to 23.8 million. In its letter to shareholders, the company itself wrote that the episode around the new name had further damaged its reputation and triggered a temporary surge of cancellations, but that the price change had had a greater effect.

For the principle that openness creates more trust than staging, this episode is a good example. The strategic direction was right, as the following years showed. What failed at first was the way it was imposed on customers. How to justify and announce price changes is described in the guide raising prices without losing customers. How to deliver bad news openly is shown in the guide delivering bad news.

Two readings: foresight or luck?

The first reading sees Netflix as a lesson in foresight. The company recognized that shipping physical discs was a transitional business and built the successor while the old business was still bringing in money. It accepted that streaming would cannibalize its own DVD revenue. This is exactly what Chandy and Tellis describe as the hallmark of companies that produce fundamentally new things.

The second reading is more cautious. It points out that Netflix benefited from developments it did not control itself: faster internet connections, new devices, and capital markets that long valued growth over profit. Then there is survivorship bias: no case studies are written about companies that tried to replace their core business and failed. The mistake of 2011 also shows how close it can get.

I consider the first reading correct in direction and the second in degree. The decision to replace its own business was deliberate and well founded. That it turned out so successfully was also due to favorable circumstances. For a small business, it does not follow that every self-replacement succeeds, but that it should be planned, approached in steps, and with an open eye to the risk. How a company can miss the transformation despite its strength is shown, by contrast, in the case study on Nokia.

What small businesses can transfer

A small business does not have a streaming platform to build. But it almost always has a service whose demand will decline over time, and one that could replace it. The lesson from Netflix can be translated into five steps.

1. Assess the lifespan honestly

   Ask for each core service: will it still be in demand like this in ten years? Looking at regulations, technology, and the behavior of younger customers helps.

2. Start the successor small

   Offer the new service in addition, to a few customers first. How to test a new service before it costs a lot is described in the guide testing a new service.

3. Name a champion

   Chandy and Tellis name influential champions as one of the forces that overcome hesitation. In a small business, this means: one person is responsible for the new service and has time for it.

4. Allow cannibalization deliberately

   Decide that the new service may take customers away from the old one. Forbidding that protects yesterday.

5. Plan and explain the exit

   Set a timetable for the old service, explain it to customers early, and offer transitions. How to end a service in an orderly way is described in the guide pruning your service portfolio.

If you combine the switch with a subscription, such as a maintenance contract instead of individual orders, the guide building recurring revenue provides the building blocks. The annual strategy check offers a fixed place for the question about the lifespan of your own services.

Limits of the transfer

Three limitations belong to this case study. First, Netflix is an exceptional case with access to capital that no small business has. Second, some episodes, such as the offer to Blockbuster, rest on accounts by individual participants that others dispute. Third, Chandy and Tellis's findings come from high-tech industries and large companies. Whether the willingness to cannibalize works the same way in a trades business has not been studied.

• For every core service, it has been estimated how long it will remain viable.
• There is a named successor for the service with the shortest lifespan.
• One person is responsible for the successor and has fixed time for it.
• Customers learn early and openly what is changing and what they gain from it.
• Price changes during the transition are justified and not used as a lever.

Conclusion: how a DVD rental service replaced its own business

To answer the guiding question: Netflix replaced its own business by building the successor while the old business was still viable, deliberately accepting the cannibalization of DVD revenue, and letting the old business run down over 16 years instead of ending it abruptly. Chandy and Tellis's model explains why this attitude is rare: those who have invested heavily in the existing business would rather protect it than replace it themselves.

But the case also shows that the right direction alone is not enough. In 2011, a poorly explained change in price and structure cost around 800,000 customers in one quarter. For small businesses, this may be the more important lesson: building the successor in good time is a strategic task; explaining the transition openly to customers is a matter of trust.